Sunday, November 8, 2015

Butter Bubble Grows

One November 2, 2015, Class and component prices were announced for October. The Class III price was down slightly at $15.46/cwt. compared to $15.82/cwt. the prior month. The butterfat price was again up, reaching the second highest price ever. The U.S. NASS price for butter is approximately twice the global price. With dairy evolving into an international market, sustaining the high U.S. butter price will likely be short lived.

Other solids have become essentially worthless at $.03/lb. This is the lowest price in six years.

The pie chart shown below is significantly skewed from historical proportions. Two thirds of the Class III price is now being contributed from payment for butterfat. Unfortunately, a high butter price has very little impact on the Class III price overall, and only shifts money from protein to butter. More on this below.

The long-term trend chart is shown below. While butterfat is typically worth much less than protein, butterfat currently is valued at $2.91/lb. while protein is valued at $1.70/lb.

Driving these unusual prices is what can best be described as a bubble market price for butter. The CME futures market is projecting a price decline of 25% by year end.

Butter churning is continuing to decline at a time when butter consumption is up. The chart below indicates about a 10% reduction in butter churning over the last three years.

The balance of butter supply is being made up by reduced exports and record imports. Exports are trending near zero and imports continue to be at record levels, leaving the U.S. as a net butter importer. Dairy imports and exports will be examined in detail in an upcoming post to this blog.

The low production, low exports and record imports of butter have resulted in inventory levels that parallel historic levels. Butter inventories are higher than a year ago and lower than the prior two years. While the pricing of dairy products typically follow the Keynesian economics of supply and demand. That is currently not the case. Inventories can best be expressed as "normal," and the price is at near record highs.

The price of milk protein is calculated by a slightly complex formula involving the wholesale price of cheese and butter.

Because milk protein is essential to economical production of cheese, the milk protein price is tightly tied to the NASS price for cheese. However, butterfat in cheese is typically worth more when used in cheese rather than butter, and that extra value is given to the calculated value of milk protein. While the formula remains the same, currently the part of the formula involving butterfat has gone negative.

The depth of this impact is shown below. The butter price impact is currently not only negative, but is at a record level of negative value. The price of milk protein is down because the price of butter is up. (Click here for more details on this relationship.)

One more factor that is currently unusual is the pricing of Class I milk. The price of Class I milk is based on the higher of the Class III or Class IV advanced price.

The price of Class IV milk is based on the NASS value for nonfat dry milk. Because NDM is a strongly exported commodity, the price has been depressed. In October, the price did improve resulting in a higher Class IV price that has exceeded the Class III price (see chart above). Therefore the Class I price is higher

What impact does this have? For those paid on the Federal Milk Marketing Order advanced system, this is a very positive event. It improves the price of Class I milk and most milk paid on the advanced system is Class I milk. For those paid on the component system, the higher Class I price will have a positive impact of the Producer Price Differential.

What does all this mean for dairy producer milk prices? Because cheese prices have little reason to change in the near future, little change is anticipated in the Class III price. However, the bursting of the butter bubble will shift the payment to higher pay for milk protein and lower pay for butterfat. This represents a change to more normal prices which means that producer revenue can best be increased by increasing protein production as much as possible.

Exports continue to have a major impact and will be reviewed in the next post.